Business Combination

3 Months Ended

Mar. 31, 2013

Business Combination

Note 7. Business Combination

Optical Components Business Unit (OCU)

On March 29, 2013 (the “closing date”) the Company acquired certain assets and assumed certain liabilities related to the Optical Components Business Unit (the “OCU”) of Lapis Semiconductor Co., Ltd., a wholly owned subsidiary of Rohm Co., Ltd (“Lapis”) of Japan with the intention of operating the OCU as an ongoing business. The business is now known as NeoPhotonics Semiconductor.

The OCU is a leader in high speed semiconductor and high speed laser and photodetector devices for communications networks. The Company believes the acquisition will expand the Company’s solutions for high speed telecom and datacom applications and strengthen the Company’s customer base in Japan.

Total consideration for the OCU was approximately $24.3 million, including cash of $14.1 million paid upon closing and notes payable of $11.1 million, partially offset by a net receivable from Lapis of $1.0 million related to a working capital adjustment and certain other payments between the Company and Lapis. The cash of $14.1 million includes $2.0 million that was withheld and placed into escrow to cover certain indemnity obligations from the closing date through March 29, 2014. The notes payable of $11.1 million are to be paid in three equal installments on the first, second and third anniversaries of the closing date. Each year an additional amount calculated as 1.5% per year of the unpaid balance of the notes becomes due. Lapis retains a lien on the land and building sold until the third payment is paid. The purchase price consideration and payment of notes payable are denominated in Japanese Yen.

In connection with the acquisition, the Company incurred approximately $4.5 million in acquisition-related transaction costs related to investment banking, legal, accounting and other professional services and fees and transfer and acquisition taxes related to real property acquired. The acquisition costs were expensed as incurred and were included in operating expenses in the Company’s condensed consolidated statement of operations in the first quarter of 2013.

The OCU’s results of operations between the closing date of March 29, 2013 and the Company’s quarter end date of March 31, 2013 were immaterial.

Assets Acquired and Liabilities Assumed

The Company accounted for its acquisition of the OCU assets and assumed liabilities as a business combination. The OCU’s tangible and identifiable intangible assets acquired and liabilities assumed were recorded based upon their estimated fair values as of the closing date of the acquisition. After consideration of the purchase accounting corrections (see Note 2) the estimated fair values of the identifiable assets acquired and liabilities assumed approximated the purchase price; therefore, no goodwill was recorded.  A preliminary assessment of the fair value of assets acquired and liabilities assumed (“initial preliminary fair value assessment”) was made as of March 29, 2013.

During the quarter ended September 30, 2013 the Company updated its initial preliminary fair value assessment and has reflected the resulting measurement period adjustments as Revisions in the accompanying March 31, 2013 condensed consolidated balance sheet.  These adjustments were based on additional information received subsequent to the Company’s initial assessment that had a significant impact on a number of assumptions, including those related to inventory obsolescence, gross margin and working capital.  The adjustments include a decrease in the fair value of inventory of $6.7 million and increases in the fair value of property, plant and equipment of $2.8 million and customer relationships of $1.7 million.  

The following table summarizes the acquisition accounting and the tangible and intangible assets acquired (in thousands):

Total purchase consideration:
Cash paid upon closing	$	14,087
Net receivable from Lapis		(959	)
Notes payable		11,130
	$	24,258
Liabilities assumed:
Pension and retirement obligations	$	6,471
Other compensation-related liabilities		1,083
Other current liabilities		1,265
	$	8,819
Fair value of assets acquired:
Inventory	$	13,309
Other current assets		35
Land, property, plant and equipment(1)		14,433
Intangible assets acquired:
Developed technology		2,120
Customer relationships		3,180
	$	33,077

⁽¹⁾ Includes land of $3.5 million, buildings of $3.9 million and machinery, equipment, furniture and fixtures of $7.0 million.

The approach for measuring the fair value of the assets acquired and liabilities assumed is described below:

Net Tangible Assets

The OCU’s tangible assets acquired and liabilities assumed as of March 29, 2013 were recorded at estimated fair value with the exception of the pension and retirement obligations. The Company estimated fair value by adjusting the OCU’s historical value of property, plant and equipment to an estimate of depreciated replacement cost, adjusted for economic obsolescence. The Company depreciates property, plant and equipment over estimated lives of 2 to 10 years, and records the expense to cost of goods sold and operating expense. The fair value of inventory acquired was determined using a net realizable value approach based upon the expected sales value of the inventory, less any costs to complete and selling costs along with a reasonable profit margin based on historical and expected results. The fair value of accrued liabilities approximated the amounts due under the arrangements with employees and vendors due to short maturity. Pensions and retirement obligations are recorded to the extent the projected benefit obligation exceeded the fair value of the plan assets estimated as of March 29, 2013. The projected benefit obligation is measured at the actuarial present value of all benefits attributed by the plan's benefit formula to employee service rendered before March 29, 2013.

Intangible Assets

Developed technology represents products that have reached technological feasibility. The OCU’s current product offerings include high speed semiconductor and high speed laser and photodetector devices for communication networks. The fair value of developed technology intangibles acquired was determined by using a royalty-avoidance method. The share of future revenue relating to current technology was forecasted, using an estimate for obsolescence such that the share declines over time. A royalty rate of two percent was used to calculate royalty savings on that revenue that are avoided since the Company owns the technology and does not need to license it from other parties. The after-tax royalty savings was then discounted to present value using the Company’s discount rate. The Company amortizes the developed technology intangible assets over estimated lives of 4 to 5 years, and amortization expense is recorded to cost of goods sold.

The customer relationships asset represents the value of the ability to sell existing, in-process, and future versions of the technology to the OCU existing customer base. The Company utilized the excess earnings method, estimating future cash flows that will result from existing customers given assumed retention rates, and then discounting those flows to their present value using the Company’s discount rate. The Company amortizes the customer relationships intangible asset over an average estimated life of 6 years, and amortization expense is recorded to operating expenses.

The weighted average amortization period for the total amount of intangible assets acquired is 5.4 years.

Pro Forma Financial Information

The unaudited financial information in the table below summarizes the combined results of operations of the Company with the results of OCU prior to the acquisition, on a pro forma basis, as though the companies had been combined as of the beginning of the period presented. The pro forma financial information for the quarter ended March 31, 2013 includes elimination of $4.5 million of transaction costs and $1.9 million of revenue and $1.8 million of costs related to sales from OCU to the Company.  The pro forma financial information for the quarter ended March 31, 2012 includes elimination of $0.4 million of revenue and $0.3 million of costs related to sales from OCU to the Company and a $2.5 million increase in cost of goods sold due to a change in the value of inventory as a result of acquisition accounting.  The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved had the acquisition taken place at the beginning of the period presented, nor does it intend to be a projection of future results.

	For the three months ended March 31,
	2013			2012
Revenue	$	68,754		$	67,537
Net loss	$	(5,277	)	$	(12,038	)
Basic and diluted net loss per share	$	(0.17	)	$	(0.48	)